Fed study: Tennessee has most regressive tax system

Fed study: Tennessee has most regressive tax system

May 27th, 2015 by Dave Flessner in Business Around the Region

State taxes and inequality

States that boost income inequality the most:
1. Tennessee, offsets 32.7 percent of the progressiveness of the federal tax code
2. Mississippi, offsets 32.2 percent of the progressiveness of the federal tax code
3. West Virginia, offsets 31.6 percent of the progressiveness of the federal tax code
4. Louisiana, offsets 22.4 percent of the progressiveness of the federal tax code
5. South Dakota, offsets 20.8 percent of the progressiveness of the federal tax code

States that reduce income inequality the most:
1. Minnesota, increases the progressiveness of the federal tax code by 18.1 percent
2. Oregon, increases the progressiveness of the federal tax code by 17.7 percent
3. Wisconsin, increases the progressiveness of the federal tax code by 13.7 percent
4. Hawaii, increases the progressiveness of the federal tax code by 12.1 percent
5. Delaware, increases the progressiveness of the federal tax code by 11.6 percent
Source: Federal Reserve Bank study on "The Role of Taxes in Mitigating Income Inequality Across the U.S. States," May 2015 by Daniel H. Cooper, Byron F. Lutz, Michael G. Palumbo.

Document: Taxes and income inequality

Read study on "The Role of Taxes in Mitigating Income Inequality Across the U.S. States."

A new study by a trio of economists from the Federal Reserve Bank found that Tennessee has the most regressive tax system of any state, requiring poor and middle-class taxpayers, in most instances, to pay a bigger share of their income than do wealthy individuals in the Volunteer State.

While the federal tax code helps to reduce America's growing income inequality, Tennessee's regressive tax system undoes much of the inequality-reducing force of federal taxes, the Fed study found. Tennessee boasts some of the lowest overall tax rates of any state, but its heavy reliance upon the sales tax for the biggest share of state revenues means that a disproportionate share of the taxes paid comes from low- and middle-income taxpayers.

"The tax systems in a handful of states, including Mississippi, Tennessee and West Virginia, widen the income distribution sufficiently to reverse around one-third of the compression achieved by the federal tax code," Daniel H. Cooper, senior economist in the research department at the Federal Reserve Bank in Boston wrote in a new study he co-authoried with two economists with the Federal Reserve Banks's fiscal division on research and statistics in Washington, D.C. -- Byron Lutz and Michael Palumbo.

Most states exempt food and clothing from state sales taxes, which Tennesssee does not, and most states have some type of payroll tax on income, which Tennessee and six other states do not.

Low-income people often pay 10 percent or more of their income in sales and property taxes (often paid through rent), while upper- income people in Tennessee may pay only 2 to 3 percent of their income in state taxes because much of what they spend their money on or earn income from is not taxed.

"This study confirms that our tax system in Tennessee is upside down and imposes a much bigger tax burden on those who are least able to afford it," said Dick Williams, chairman of the Tennesseans for Fair Taxation, a statewide group that has lobbied unsuccessfully for decades to try to get Tennessee to adopt a state income tax.

But Tennesseans appear in no mood to want to adopt any tax on payroll or income, even though proponents of such a tax claim it could reduce the overall tax burden for many households. Last November, Tennesseans voted by nearly a 2-to-1 margin -- 882,926 to 450,522 -- to ratify a state constitutional amendment to ban the adoption of state or local tax upon payroll or earned personal income.

"There is virtually no support anywhere for an income tax in Tennessee and overall I think our tax system has worked well to provide a stable and growing source of income," Tennessee House Majority Leader Gerald McCormick, R-Chattanooga, said Tuesday.

McCormick said the federal tax code may be more progressive, but it also fuels a government that is too big and expensive. Adopting an income tax usually leads to higher overall taxes by state government and makes such states more susceptible to fluctuations in the economy.

"The sales tax is a reliable, stable source of revenue," Tennessee State Senate Majority Pro Tem Bo Watson, R-Chattanooga, said.

The Tax Foundation lists Tennessee as the sixth lowest state for overall state and local tax burdens and ranks Tennessee 15th among the 50 states in its overall business climate.

Justin Owen, president of the conservative think tank, the Beacon Center of Tennessee, said not having an income tax in Tennessee "creates more jobs and further encourages the surge of migration into our state from those who are seeking to escape states that have heavy-handed tax policies."

Owen said income inequality in Tennessee's tax system could be addressed by ending what he says are "corporate welfare schemes" that give state assistance or tax breaks to companies that relocate or expand in Tennessee.

"Massive corporations receive hundreds of millions of our fellow Tennesseans' tax dollars," he said. "We should work to keep taxes low across the board and treat all Tennesseans fairly, rather than create a tax system -- like we have at the federal level -- that takes from some to give to others and allows the government to pick winners and losers in business."

Contact Dave Flessner at dflessner@timesfreepress.com or at 757-6340.